I What’s new on our websiteIMF unveils its online database on Financial Access

II World Bank researchCan banks be too big to save?Deals versus rules: The plight of African firmsThe impact of the business environment on young firm financing Liquidity clienteles: Transaction costs and investment decisions of individual investorsIs there a distress risk anomaly? Corporate bond spreads as a proxy for default risk

III “FYI”: Our eclectic guide to recent research of interestOn the effectiveness of Asian banking reformChina‘s high saving rate: myth and realityThe impact of bank accounts on migrant savings and remittancesSavings accounts for migrants and remittance recipients: does control matter?A behavioral explanation for the success of microcredit

IV Upcoming events and miscellaneaThe evolution of banking in the industrialized world since 1800Save the date for the thirteenth annual International Banking Conference

The next issue of Interest Bearing Notes will appear in September 2010 so please send comments, suggestions (such as your own or others’ interesting research), and requests to be added to our distribution list, to Agnes Yaptenco (mailto:ayaptenco@worldbank.org) by September10th.

IBN is a product of the Finance and Private Sector Development Team in the World Bank’s Development Research Group. Our working papers and descriptions of research projects in progress can be found, along with a list of forthcoming seminars and conferences, on our web page (http://econ.worldbank.org/programs/finance).

I What’s new on our website

IMF unveils its online database on Financial AccessBuilding on our research, the IMF recently launched a new online database on financial access, which should start measuring access to and use of financial services systematically. The database measures the reach of financial services by bank branch network, availability of automated teller machines, and by four key financial instruments: deposits, loans, debt securities issued, and insurance. The website contains annual data from about 140 respondents for the six-year period, including data for all G-20 countries. Read more here.

II World Bank research

Can banks be too big to save?Our own Asli Demirguc-Kunt and co-author Harry Huizinga investigate the link between government finances and potential bail-outs of systemically large banks. Variation in the share prices of 717 publicly-listed banks in 34 countries from 1991 to 2008 and the spreads on the credit default swaps (CDS) of 59 banks in 20 countries from 2001 to 2008 tell a similar story. Increased government indebtedness was associated with declining share prices and widening spreads at the time of the 2008 financial crisis, and the effects were more pronounced for systemically large banks, consistent with the notion that investors had doubts about the willingness and/or ability of governments to assist them because they had become too big to save. At the same time, the volatility of weekly bank stock returns, a measure of bank risk, was positively linked to share prices and negatively linked to CDS spreads for all banks, but especially so for systemically large ones, findings consistent with the more traditional view that banks can become too big to fail. Asli and Harry interpret these results as indicating that low-risk banks in high-deficit countries have grown beyond the size that maximizes their implicit subsidy from the financial safety net. Such banks should find it in their interest to downsize or split up and, in fact, the share of systemically important banks (relative to GDP) declined in 2008 relative to the previous two years, perhaps reflecting these incentives. Probably closer to the first word than the last on this topic, but certainly a useful and highly timely analysis linking the recent deterioration in government finances to the potential for future bail-outs of systemically large banks.http://go.worldbank.org/EUUZXSW6P0

Deals versus rules: The plight of African firmsA recent paper by Mary Hallward-Driemeier, Gita Khun-Jush, and Lant Pritchett shows that the within-country variation in many of the variables from the World Bank Investment Climate Surveys, including the need to make informal payments (bribes) to government officials and the extent of political connections, is greater than the cross-national differences in the average values of these variables. The wide variation in those variables is surprising in that firms in the same country notionally face the same government policy. Mary et al. then show that variation in those measures of policy implementation “uncertainty” within location-sector-size cells is correlated with firm growth rates. They conclude that African firms don’t simply comply with policy rules but are forced to craft their own highly specific deals, making bribes and using their personal connections to get things done. As further evidence in support of that proposition, they show that the policy actions taken by individual firms explain much more variation in employment growth than either the average measures of policy actions in a country or the “Doing Business” indicators. The evidence also indicates that firms’ need to take these policy actions grows with the formal regulatory burden, which suggests that more burdensome processes provide more opportunity for crafting such deals. Focusing on within-country variation and the deals firms create marks an important shift away from discussions of a general policy environment based on comparisons across countries. http://go.worldbank.org/JQ4X4VUJC1

The impact of the business environment on young firm financing It has been often noted that new firms without a proven track record experience more severe financing constraints relative to older, more mature firms. However, comparable cross-country data on young firm financing have not been available until recently. In this paper, Larry Chavis, Leora Klapper, and Inessa Love use data from Enterprise Surveys on over 70,000 firms in over 100 countries collected by the World Bank to study the financing patterns of young firms. The authors confirm that in all countries younger firms rely less on bank financing and more on informal financing. Moving beyond simple cross-country analysis the authors explore whether the institutional environment affects young firms differently from older, more mature firms. They find that younger firms use more bank finance in countries with a stronger rule of law and better credit information, and that the reliance of young firms on informal finance decreases with the availability of credit information. Overall, the results suggest that improvements in the legal environment and availability of credit information are disproportionately beneficial for promoting access to formal finance by young firms.http://go.worldbank.org/5F3ASOI000

Liquidity clienteles: Transaction costs and investment decisions of individual investors In this paper, a new member of our team, Deniz Anginer explores the asset pricing phenomenon known as the “clientele effect” that arises because of differences in the transaction costs of different securities. Because security trading costs have to be amortized over the expected holding period of a security, investors with longer holding periods choose to hold stocks with higher transaction costs in equilibrium. Using a unique dataset, Deniz investigates the liquidity decisions of 66,000 households that made over two million trades using a large discount brokerage over a six-year time period. He finds that more sophisticated investors tend to pay more attention to liquidity than less sophisticated investors. In addition, more sophisticated investors have holding periods that are positively correlated with measures of transaction costs, while the same correlation is negative for less sophisticated investors. In addition, he finds that households with longer holding periods earn returns net of amortized transaction costs that are greater than the net returns of households with shorter holding periods. In other words, households that do not pay attention to liquidity earn lower returns on both a gross and net basis. One implication of this result is that investors should consider the expected holding period together with transaction costs, remembering that longer holding periods are needed to amortize higher transaction costs. These results have an implication for the security trading tax that has been proposed to minimize speculative trading. While the tax is likely to reduce trading, it will have unequal consequences for more versus less sophisticated investors and will likely be more harmful for the latter group.http://go.worldbank.org/J1O6H9M4P0

Is there a distress risk anomaly? Corporate bond spreads as a proxy for default riskAnother recent paper from Deniz Anginer with co-author Celim Yildizhan explores whether corporate default risk is priced into stock returns. Unlike previous papers that documented low stock returns for companies with higher default risk bonds (a relationship that should at best go in the opposite direction – i.e. higher risk – higher return), this new work, which uses market-based measures of credit spreads as a proxy for the likelihood of default, does not find such an anomaly. Unlike the previously used measures that proxy for a firm’s real-world probability of default, credit spreads proxy for a risk-adjusted (or a risk-neutral) probability of default and thereby explicitly account for the systematic component of distress risk. The authors show that credit spreads predict corporate defaults better than previously used measures, such as bond ratings, accounting variables and structural model parameters. They do not find default risk to be significantly priced into the cross-section of equity returns, but they also find no evidence that firms with high default risk deliver anomalously low returns. Besides adding a solid piece of evidence to the debate of whether default risk is priced in or not, this paper underscores the importance of properly measuring default risk, which plays an important role in many other applications.http://go.worldbank.org/969H8NRZD0

III “FYI”: Our eclectic guide to recent research of interest

On the effectiveness of Asian banking reformMadhusudan Mohanty and Philip Turner provide an excellent summary of banking sector development in Asia since the 1997-8 crisis and explain why those sectors have weathered the current crisis rather well. The share of non-performing loans has dropped substantially, in part because of restrictions on credit exposures to single borrowers and to groups of borrowers in most countries and prohibitions on lending to bank shareholders in some countries. In turn, capitalization ratios and profitability have climbed. At the same time, the authors caution that this progress must be viewed against the backdrop of some highly favorable macroeconomic circumstances. First, the marginal propensity to save in developing Asian economies increased substantially, led by China and India. In the wake of the Asian financial crisis, risk-averse households searched for less risky assets, and guarantees to bank liabilities served to channel surplus savings into bank deposits. Rapid growth in local deposits and a substantial increase in the share of lending in local currency reduced Asian vulnerability in the current crisis (as reported on in the Kamil and Rai paper in the May IBN issue). At the same time, sterilized interventions by Asian central banks to resist currency appreciation resulted in a proliferation of government debt instruments. Given the relative under-development of Asian bond markets, a large share of those instruments has come to be held by the dominant financial intermediaries, banks. These developments have left Asian banks with high shares of liquid assets. Well-capitalized, highly liquid banks should be a boon to the Asian economies, but the authors point out that strong liquidity positions allow increases in market and credit risk to go undetected for some time, and banking crises tend to materialize only after favorable macroeconomic and liquidity conditions have turned for the worse. And there are lingering underlying deficiencies in the banking environment: a lack of solid statistics on default rates, inadequate protection of lenders’ rights, large implicit guarantees that mask banks’ true ratings, and persistently high cost ratios. So while some progress has been made, this is no time for Asia’s bank supervisors to become complacent.http://www.bis.org/publ/work313.htm

China‘s high saving rate: myth and realityWhile savings rates in Asia are high, China’s stands out. By international or historical standards, Guonan Ma and Wang Yi point out that a national savings rate above 50% of GDP is remarkable. Yet, China’s corporate savings rate is close to Japan’s, its household savings rate is below India’s, and its government savings rate is less than Korea’s. What sets China apart from other countries, however, is that it ranks among the leaders on all three components of savings. While no single theory can account for China’s savings rate, the authors point to a number of structural changes as contributing factors. Large-scale rural to urban labor migration and the declining share of employment in agriculture (from 70% to 40% over the past thirty years) has raised incomes. While the same phenomenon has occurred in other countries, effects could be more pronounced in China due to a rapid demographic transition. Owing in part to the one-child policy, the dependency ratio fell from 68% to 38% within a generation, resulting in a surge in the working-age population. Deep corporate restructuring brought about a steep reduction in employment in state-owned enterprises. By boosting corporate efficiency and reducing job security, the authors argue that restructuring lifted both corporate and household savings. Similarly, less generous pension benefits and doing away with state provision of housing have given households further reasons to save. They find much less support for explanations rooted in government distortions and subsidies (state-run monopolies, financial repression, restrictions on rural labor migration, subsidies for energy inputs, below-market prices for land), in large part because the private sector, which benefits less if at all from these distortions, has fueled China’s growth while the state sector’s market share has been declining.http://www.bis.org/publ/work312.htm

The impact of bank accounts on migrant savings and remittancesA new paper by Aimee Chin, Léonie Karkoviata, and Nathaniel Wilcox examines the causal effect of having a bank account on the savings, remittances, and income of Mexican migrants in the U.S. The authors conducted a field experiment where they offered a randomly selected treatment group of previously unbanked migrants assistance with obtaining a consular ID card that banks accept as a form of identification for opening an account. This intervention generated exogenous variation in having a U.S. bank account: migrants in the treatment group were 38 percent more likely to open a bank account than migrants in the control group. The authors note that, in the city where their experiment took place, the consular ID card has little other use besides enabling holders to open U.S. bank accounts, implying that any differences between treatment and control groups at follow-up can be attributed to obtaining a U.S. bank account. The follow-up survey shows that, five months after the start of the experiment, treated migrants increased their savings as a share of income by 9 percentage points and decreased their remittances to Mexico as a share of income by 6 percentage points. These effects are even larger for migrants who report that they have “no control” over how their remittances are allocated in Mexico. The authors attribute these findings to the fact that a U.S. bank account provides a safe store of money for migrants who would otherwise have to hold cash (running the risk that cash may be stolen) or send the money to Mexico (where they may have little control over whether their family saves the money or not). In fact, for migrants with “no control” over how their remittances are allocated, the authors find that income increases as a result of obtaining a U.S. bank account, suggesting that having a safe store of money increases their incentives to work.http://www.uh.edu/~achin/research/ckw_banking_june2010.pdf

Savings accounts for migrants and remittance recipients: does control matter?In a related and contemporaneous study, Nava Ashraf, Diego Aycinena, Claudia Martinez, and Dean Yang investigate in more detail how important migrants’ control over their remittances is for savings accumulation. The authors conducted a survey among El Salvadorian migrants in the US and their families in El Salvador. In the survey, migrants report that they would like recipient households to save 21% of remittance receipts, whereas recipient households prefer to save only 2.6% of receipts. The authors then designed a field experiment that gave migrants different options for opening savings accounts in El Salvador that they could deposit money into from the US. Migrants in the study were randomly divided into one control and three treatment groups. The first treatment group was offered the option of opening a savings account in El Salvador in the name of a remittance recipient in El Salvador. The second treatment group additionally had the option of opening a joint account in El Salvador for the migrant and remittance recipient. The third treatment group could open either an account in somebody else’s name, a joint account, or an individual account only in the migrant’s name. Follow-up results show that the migrants who only had the opportunity to open and remit into bank accounts in the name of remittance recipients or into joint accounts do not save more than the control group. However, migrants who had the opportunity to open individual accounts in addition to joint accounts save significantly more than the control group. This suggests that new financial products can encourage migrant savings (which in turn could have positive impacts on investment in education, health, and microenterprises). However, savings may not increase if recipients rather than migrants have control over the funds.http://www-personal.umich.edu/~deanyang/papers/aamy_remittancecontrol.pdf

A behavioral explanation for the success of microcreditIt is often argued that microcredit is successful in lending to traditionally un-bankable individuals since its group lending structure mitigates moral hazard and adverse selection. Moreover, microcredit group meetings can reduce transaction costs since they allow loan officers to interact with many customers in one place. In “Behavioral Foundations of Microcredit: Experimental and Survey Evidence from Rural India,” Michal Bauer, Julie Chytilová, and Jonathan Morduch uncover another potential reason why microcredit has been on the rise. Based on behavioral economics, they argue that group-based lending, as well as the requirement to repay loans in regular, frequent, and fixed installments can act as a disciplining device for individuals with self-control problems, i.e. individuals with present-biased preferences. The authors conduct a survey in rural India to measure time preferences and find that almost one third of individuals have present-biased time presences. These preferences do not appear to be correlated with education, age, income, or wealth. The authors then examine the relationship between time preferences and financial behavior and find that women with present-biased preferences are more likely to have a loan. Moreover, conditional on having any loan, women with present-biased preferences are more likely than others to borrow through microcredit institutions. This finding is supportive of microcredit as a disciplining device, and the authors argue that it can explain why microcredit institutions that drop joint liability from their contracts nevertheless have maintained regular repayment schedules and group meetings.http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1598959

IV Upcoming event and miscellanea

The evolution of banking in the industrialized world since 1800For readers interested in a comparative historical analysis of the evolution of commercial banking in the developed world focusing on crises, bailouts, mergers, and regulation, Princeton University Press has just released Unsettled Account: The Evolution of Banking in the Industrialized World since 1800, by RichardGrossman. For more information see http://press.princeton.edu/titles/9219.html